Recent Russian Moves Proves Risky for Investors

The Russian economy offers lots of opportunities for investors to make and to lose moneyand not just in Russia.

By Marlene Y. Satter|March 19, 2014 at 09:20 PM

X

Share with Email

sending now...

Thank you for sharing!

Your article was successfully shared with the contacts you provided.

The Russian economy offers lots of opportunities for investors to make and to lose money—and not just in Russia.

That became blazingly clear in the wake of the Sochi Olympics. Escalating political protests in Ukraine intensified after its president junked a European Union treaty in favor of closer ties with Russia. Then, after Ukraine’s president fled the country, it found itself the target of Russian intervention as troops sent by Moscow entered Crimea under the guise of military maneuvers, then declined to leave. Ukraine called it an invasion, and markets reacted violently.

President Putin’s $51 billion Sochi sports extravaganza, meant to highlight Russia’s 21st-century potential in a myriad of ways, had barely dropped the curtain on its closing ceremonies when the situation in Ukraine showed Putin for what he was: a throwback to the Cold War authoritarian regime that the rest of the world hoped was long over.

And even Sochi hadn’t been the opulent panoply of opportunity Putin had hoped for. The hacking and even expulsion of foreign journalists failed to quell criticism of everything from incomplete and inadequate hotels and venue facilities to Russia’s stifling of political protest; disregard for local residents’ well-being; human rights violations; LGBT discrimination; environmental damage; and even animal cruelty. Not exactly the best marketing opportunity for a country with one foot in the 21st century and the other firmly in the mid-20th—or possibly even the 19th.

But with Sochi’s events ended and the presence of Russian soldiers in Crimea promising at the very least a protracted diplomatic standoff, if not outright military action, Russia’s economic situation is far from stable,

While Russia does offer plenty of potential, it’s definitely not for the faint of heart. Reaching from Europe to the Pacific Ocean in breadth and from the Arctic Ocean south to China in length, in geographic area the country is 1.8 times the size of the U.S. That means it’s loaded with diverse populations, climates, natural resources and opportunities. Climate and terrain issues make it challenging for the country to take full advantage of those natural resources, however, so much of its natural wealth is unrealized.

But its political climate, regressing under Putin toward the totalitarian atmosphere of its past time at the head of the USSR, means that progress—if any—has been slow in business matters. Corruption, political cronyism and government intervention make for an uncomfortable economic climate, and Putin’s latest display of Russia’s might has already taken its toll on Russia’s stocks, bonds and currency, as anxious investors have sold off holdings from equities to rubles to bonds.

Moscow’s stock market dropped 11.3% of its value in a single day on March 3, losing almost $60 billion—way more than the cost of the entire Sochi spectacle—and the central bank had to intervene to protect the ruble from crashing, injecting $10 billion of its gold and forex reserves into the marketplace. It also raised interest rates to 7% from 5.5% to try to keep funds at home.

Markets tanked globally, too, as Putin inserted himself into Ukraine’s domestic argument with its president over whether to join the EU or turn its back on broader global presence and instead move closer to Russia. Volatility in the EU soared on Tuesday, hitting its highest level since 2011, as anxious investors drove up the VStoxx Index by 30%—the index is based on the prices of options that protect against losses on the Euro Stoxx 50—and fears about energy supply saw the Euro Stoxx 50 fall by 3%, the most it’s dropped in eight months.

But Putin holds all the cards, and he hasn’t hesitated to play at least some of them in the past. Conspicuous military exercises in Crimea may have ended, but Russian troops remain on the scene. In addition to this show of force, Russia has threatened to turn off Gazprom’s natural gas pipeline supply to Ukraine if the latter doesn’t fork over $1.55 billion it already owes the former for delivered goods. Payment of that size is unlikely in the extreme, since Ukraine’s current government is flat broke; its former president stands accused, among other things, of looting the country’s treasury.

Russia’s influence, however, reaches far beyond its borders. And Putin has played that card at least twice before, shutting down the supply of gas to Ukraine and, more broadly, to Europe—since the same pipelines that carry gas to Ukraine must also be used in many areas to provide EU countries with their purchases. That threatens the regularity of Europe’s natural gas supply, since Russia provides approximately 30% to European countries and about half of that goes through Ukraine pipelines.

With all that volatility and the losses in the markets, Russia’s already minuscule economic growth of 1.3% in 2013 threatens to flat line in 2014, or even head for negative numbers. Add to that the possibility of economic sanctions from the West, already being discussed because of Russia’s aggressive approach toward Ukraine, and the possibilities for recession multiply.

Although sanctions may not be the most probable Western response to Putin’s actions, their looming potential will not do much to spur foreign investment in Russia—which the country sorely needs. With foreign direct investment already in the negative instead of growing, Russia could find itself in a very tight spot indeed.

ThinkAdvisor

Free unlimited access to ThinkAdvisor.com which provides advisors, like you, with comprehensive coverage of the products, services and trends necessary to guide your clients in making critical wealth, health and life decisions.

Exclusive discounts on ALM and ThinkAdvisor events.

Access to other award-winning ALM websites including TreasuryandRisk.com and Law.com.